Question 10.

Pg 479-pg 480 example 10.1

Difference bet substantive tests of transactions and substantive test of balances.

Accounts receivable (debtor A)

Final Test balance (will appear in balance sheet) for accts receivable (common audit
procedure is send out confirmations to debtor

testing individual transactions that make up the balance for tests of transactions. (audit
procedure would be: supporting documentation like sales invoice and shipping documents.

Cash receipts, validated slips

Substantive test of balance – if I have many small individual transactions

Substantive test of transactions - very few large transactions

For inventory: look at balances, test of balances, common audit procedure for testing
inventory: tend (physical examination) stock take and do test counts.

Qns 10.16

Non current liabilities (equity)

Which assertion: completeness

Detect understatement of liabilities, unrecorded liabilities (most concerned with), greater

risk of understatement,

Completeness of owner’s equity. Any issue of new shares

Higher risk of understatement of liabilities.

Question 10.17:

Test balances in income statement

Substantiation by simultaneous test

Sale on credit (example) : debit accts receivable, credit sales.

If testing accounts receivable (example its existence): verifying the occurrence of the sales
transactions (substantiation of simultaneous test) Testing both sides of the transactions.

Test financial statement balance, indirectly testing income statement items as well
(occurrence of sales transactions)
Sells the goods. Entry to update perpetual inventory. Journal entry would be, debit cogs,
credit inventory. Test inventory, indirectly testing cogs as well.

Substantiation directly in conjunction with balance sheet accounts, for some income
statement account balances, verified when undertaking related balance sheet accounts,
depreciation expense (example), verifying ppe, test depreciation expense at the same time.

Example here: loans, verifying loans (liability) balance sheet account, directly testing interest
expense (income statement).

3rd way: substantiate directly by analytical procedures.

To determine if amounts are reasonable (comparing prior years with current years).

Accounts that have relationship with other accounts, sales commission, directly related to
sales. Cost of sales will also go up, sales and cost of sales.

Accounts receivable go up, doubtful debt will go up also.

Looking for logical relationships.

Last way substantiation by separate test for these balances

Perform direct test of balances: individually significant transactions or there could be

transaction balances with intrinsic value to auditors. Accounting principle changes or
discontinued operations

Contingincies, contingent liability( may not be able to pick up with regard to previous
methods), legal fees, auditors fees, director fees, separately disclosed in the financial
statement separate substantive test for these items.

Question 10.23

Risk of material misstatement.

7.26 to answer this question.

Accounts receivable, increasing. 20% increase in accounts receivable. Accounts receivable

turnover slower than previous years, 4.3 times to 3.5 times, note 1 >> accounts receivable.

Drop in provision for doubtful debts (5%), 20% increase in accounts receivable. Most
concerned with valuation and allocation assertion.

Sales declined (4%), accounts receivable gone up. Main audit procedure to address risk
identified would be: firstly, adequacy for provision of doubtful debt: age listing of accounts
receivable (age debtors analysis), select a sample of older debtors from this age debtors
analysis and see whetherand see if they have subsequently paid, see subsequent cash
receipts to determine if they have been paid at year end. review correspondents files,
adequate provision provided for contentious

Inventory

It has increased by about 9.5% compared to sales, sales has decreased by 4%. Overstocking
of inventory, taking longer to sell inventory. Inventory turning over slower, bottom
paragraph of pg 346, problems selling new product, doubt as to whether they can sell new
product at existing price, may have to discount or sell at lower price. Sell at above its cost or
below what it cost them, may raise doubt about net realisable value of their stock, discount
their goods, discount inventory create net realisable value problem. Assertion concerned
here would be: valuation and allocation. Main audit procedures would be: look at the selling
prices, review sales prices on these products after year end and see if its above their cost.
Value inventory to net realisable value. Look at whether there were any damage or old
stock, would have done this when doining stock take, would have identified old and
damaged inventory. If stock around for old time, could be old and obsolete, have problem
selling it, throw into question their valuation, if nrv lower than its cost.

Sales

Pg 348 last box

Sales has decreased in first quarter, jan-march sales decreased, april-june substantial
increase, much higher than previous 2 years and also previous quarters, its unusual.

Sales may be overstated. Assertion of interest here occurrence.

Main audit procedures, vouch entries in journal to supporting documentation like sales
invoice or delivery note. To increase sales, shipping out goods at month end or were never
ordered, more than what client ordered, company could have tried to inflate sales by using
fictitious sales. Year end may have goods returned, would have ton review sales returns
after year end to see whether if there is abnormally high sales returns, ifr sales returns are
valid, not artificially increasing or inflating sales with fictitious sales. Confirm some of the
doubtful sales and return to the customers and ask customers if they ordered a particular
amount of goods.